Cezary Salad

“. . . I’d build Bear Stearns.”

If there was anything that I remembered from the brief recruiting video that I watched at a Bear Stearns recruiting session as an undergrad at Penn, it was this line. It was uttered by then-CEO Jimmy Cayne as the screen glistened with an overhead view of the octogonal 383 Madison headquarters shot from a helicopter in the Manhattan sunset.

As I sat there watching that video, I scrambled to take notes on anything anyone said. Jimmy likes bridge. Ace Greenberg is legendary. If you join Bear, you will “drink water from a water hose” and “you will be baptized by fire.”

“So if you’re an outdoors type and you like to brave the elements, this might be just the place for you,” I thought.

Two years later, Bear’s collapse and fire sale to JPMorgan for $2 per share – now quintupled to $10 per share – made me think back to the hubris on display at that recruiting session, but not with a sense of schadenfreude but rather with a sense sympathy for Bear’s recruits. Being told you’re joining the “perfect firm” only to have it collapse a few months after joining and be sold for a pittance to a competitor is not exactly the ideal way to start your career.

So what went wrong? Bear’s downfall was precipitated by bad luck but compounded significantly by mismanagement of risk and perception.

The bad luck part seems to have been a good old fashioned bank run that ensued after market rumors started to spread two weeks ago that Bear was having liquidity problems. Then, in the scope of just two days, nervous clients withdrew $17 billion of their money, effectively forcing it to find a well-capitalized buyer or face bankruptcy. Ironically, at the end of its 2007 fiscal year, Bear had actually had a quick ratio that was better than that of its peers: .78x versus an average of .66x for Morgan Stanley, JPMorgan, Goldman Sachs, Lehman Brothers, Citigroup and Merrill Lynch, which I calculated from their respective 2007 10K filings. This only reinforces the point that Bear was – as are all investment banks – trust-based businesses: to lose your counterparties’ trust is to lose your shirt. No bank is immune from such a fate.

Yet while it’s true that this could happen to any bank, Bear sure didn’t help itself by aggressively leveraging its mortgage-backed securities as high as 30-1, making their falling out of favor with investors all the more painful once the CDO market turned sour. Bear did eventually dial-down its CDO exposure after its $1.2 billion write-down in the fourth quarter of 2007. But with the yield curve steadily steepening throughout last year, did they not see the need to reduce their risk exposure earlier, before ARMs reset and foreclosures went up?

Compound this lack of foresight with the management’s inability to manage investor expectations. Despite Bear CFO Sam Molinaro’s insistence that Jimmy Cayne was always readily reachable during critical moments, it doesn’t shore up investor confidence – nor that of your counterparties – to know that the CEO can be counted to be at a bridge tournament when he is needed most. When the news broke on March 14 that Bear will seek emergency funding from the Fed, I jokingly thought, “boy, I hope Jimmy Cayne isn’t out at a bridge tournament.” Wishful thinking; he was out in Detroit at the North American Bridge Championship with former Bear bond chief and fellow bridge aficionado Warren Spector. Talk about fiddling while Rome burns.

Contrast that with how Lehman’s leadership reacted when rumors spread that Lehman Brothers might be the next bank to suffer Bear’s fate. Lehman’s stock tumbled 31% from $45.99 to a low of $31.75 but soon rebounded after CFO Erin Callan pulled all the stops during an excruciatingly detailed earnings call to reassure the market that Lehman was and would remain solvent. CEO Dick Fuld cut short his trip to India and came back to deal with the crisis.

It is still too early to tell who the survivors will be once the credit markets calm down and things return to normal. But two things are certain. First, Bear was certainly not perfect, but it didn’t have to end this way for shareholders and employees. A little less bridge and more risk and perception management would have gone a long way. And second, when this all comes to pass and things return to normal, it will be an all-together different kind of normal – so different that it begs the question: will we even recognize it when it comes?